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INTHE PREFACE to their best seller Free to Choose, Milton and Rose Friedman write, “We are still free as a people to choose whether we shall continue speeding down the ‘road to serfdom,’ as Friedrich Hayek entitled his profound and influential book …. ” Since Hayek’s book was published 40 years ago, it would seem that we have been “speeding” down that road at a remarkably sedate pace. I must confess that praise like the Friedmans’ put me off reading The Road to Serfdom until now.

That was a mistake. Hayek is well worth reading, both for what he says and for what he doesn’t say. Looking first at the latter, we find that he is far from advocating the sort of libertarian – that is, practically nonexistent state the Friedmans envisage. The Friedmans share with Marx a longing for the state to wither away, but Hayek is having none of that; he merely wants the state to act responsibly.

He is, for example, willing to consider “restricting the allowed methods of production, so long as these restrictions affect all potential producers equally and are not used as an indirect way of controlling prices and quantities …. ” He also believes that “To prohibit the use of certain poisonous substances or to require special precautions in their use, to limit working hours or to require certain sanitary arrangements, is fully compatible with the preservation of competition.” Hayek would thus not be sympathetic with the notion, advanced by both neoliberals and neoconservatives, that factories should be allowed to pollute as they please, so long as they pay a fee for the privilege.

Nor would he approve of the merger movement and the consequent concentration of power in sprawling conglomerates. He disputes, without naming him, his fellow countryman Joseph A. Schumpeter (who is at present being touted by neoconservatives as a foil to Keynes), rejecting “the myth … that … competition is spontaneously eliminated by technological changes.” In addition, Hayek quotes with favor from the New Deal report ofthe Temporary National Economic Committee: “‘The superior efficiency of large establishments has not been demonstrated … monopoly is frequently the product of factors other than the lower costs of greater size. It is attained by collusive agreement and promoted by public policies. When these agreements are invalidated and when these policies are reversed, competitive conditions can be restored.'”

In another place Hayek says, “It is only because the control of the means of production is divided among many people acting independently that nobody has complete power over us.” He is against monopoly as well as against the “monster state,” and in his last chapter, he writes (anticipating E.F. Schumacher), “It is no accident that on the whole there was more beauty and decency to be found in the life of the small peoples.”

Though Hayek’s main thesis is objection to a comprehensively planned economy, he recognizes that “the case for the state’s helping to organize a comprehensive system of social insurance is very strong.” He holds, too, that the state should be concerned in “the extremely important problem of combating general fluctuations of economic activity and the recurrent waves of large-scale unemployment which accompany them.” And strong as he is in his insistence on private property, he thinks that the case for inheritance may not be supported with “the same necessity.”

I have quoted Hayek extensively because his reputation is that of an extreme, devil-may-care, laissez-faire conservative. His book was actually greeted with qualified praise by Keynes, as Robert Heilbroner tells us in The Worldly Philosophers; but endorsements like the Friedmans’ have established his reactionary” image.” Much of Hayek’s later work, however (e.g., his attack on John Kenneth Galbraith; see” Rereading Galbraith,” NL, June 13,1983), does exhibit a hardening conservatism.

This is not, I think, an instance of the notorious syndrome whereby flaming youths turn into reactionary elders (“When old age came over them / With all its aches and qualms, / King Solomon wrote the Proverbs / And King David wrote the Psalms”[1]). Rather, it is an instance of a common, albeit little noticed, progression whereby a great leader becomes misled by his followers. The change is not always in a conservative direction. Marx became more violent and conspiratorial at least in part because his most vocal supporters were conspiratorial. John Dewey, whose Human Nature and Conduct showed strong elements of philosophical idealism, became famous for the contrary theory of instrumentalism that appealed to his admirers.

I have also seen such changes occur at less rarefied levels. One of the most delightful books I ever published was Little Britches (I was never good at titles) by Ralph Moody. It was the first of several memoirs of family life. No one reading the series would guess Little Britches was begun as a polemic against the Social Security system. But Ralph’s readers – starting with those in an extension writing course in Berkeley-praised him for the warmth of his characterizations, and he became more interested in people and less in abstract theory.

THERE ARE other interesting themes in The Road to Serfdom. One of these appears in his analysis of the failure of the Social Democrats to stop Hitler. We have heard much of the trahison[2] of the Communists; but Hayek argues that the socialist emphasis on comprehensive planning predisposed the German electorate in favor of grandiose schemes like Hitler’s. If he is right, this fact should give pause to our Atari Democrats, who want to set up a committee to decide which industries we should foster and which we should abandon and in general to plan how to use our resources. As Robert Lekachman has pointed out, such committees are more likely to be run by big business than by idealistic planners.

The Social Democrats were further weakened, Hayek says, by a split that appeared in the labor movement. For various reasons, certain unions and certain categories of workers were able to achieve remarkable economic gains, while others were left far behind. The laggers were understandably disillusioned about the Social Democrats and became ready to acquiesce in, if not support, the National Socialist program.

“To them,” Hayek writes, “and not without some justification, the more prosperous sections of the labor movement seemed to belong to the exploiting rather than to the exploited class.”

This is a problem that American labor leaders have yet to solve. The split in our labor movement was opened, as I suggested last year (“Voodoo on the Primary Trail,” NL, April 30, 1984) by the Vietnam War. But it has been astutely widened by apologists for big business and by the just- folks demeanor of President Reagan, and deepened by the misguided anti-labor Presidential campaign of Gary Hart.

It is said, by the way, that Hart appealed especially to the so-called Yuppies- young, upwardly mobile professionals. I venture to think that Hayek’s analysis of what happened in Germany is closer to what is happening here. He writes that “no single economic factor has contributed more to help [the Nazis] than the envy of the unsuccessful professional man, the university-trained engineer or lawyer, and of the ‘white-collar proletariat’ in general for the … members of the strongest trade unions whose income was many times theirs.” I suggest that the “white-collar proletariat,” hitherto most visible in countries like India, will become a growing and destabilizing factor in our public life as computerization and conglomeration steadily reduce the need for “middle management.”

Another theme of current interest in Hayek’s book is his concern over the tendency of legislatures to turn hard questions over to independent public authorities. I suppose he would therefore welcome a good deal of the current deregulation, but he would appear not to have been a knee-jerk deregulator. Hayek’s concern is also a central topic in Theodore J. Lowi‘s widely read The End of Liberalism. Both men describe the irresponsibility that results from the delegation of undefined powers. Hayek emphasizes the dictatorial arrogance that ensues; Lowi notes (as does Lekachman in the comment cited above) that ill defined regulatory commissions tend to be co-opted by the industries they regulate. A different example of irresponsible delegation is the willingness of Congress to give the President power to commit military forces to action, and indeed to launch a nuclear strike, without carefully defining limits to that power.

In the same way, control over our money, and hence over our economy as a whole, has been surrendered to the Federal Reserve Board. I regret to have to admit that three Democratic Presidents played crucial roles in the surrender: Woodrow Wilson, who admitted he knew nothing about banking, signed the Federal Reserve Act. Harry Truman allowed his Secretary of the Treasury to dissolve the agreement with the Federal Reserve that had held the prime interest rate down to 1.5 per cent during the War. Jimmy Carter appointed Paul Volcker chairman of the Fed.

How all this came about is told in fascinating and chilling detail by F.W. Maisel in a little book entitled Great American Ripoff (Condido Press, Box27551,San Diego 92128). Maisel may upset the sensitive by his espousal of a conspiracy theory of American banking; nevertheless, it’s hard to fault his facts, and I’m not even prepared to say he’s wrong about the conspiracy.

Should you feel that the bankers running the Federal Reserve, far from being conspirators, are idealistic public servants who have, in Hayek’s phrase, “devoted their lives to a single task,” there is still reason to be wary of them, for “From the saintly and single-minded idealist to the fanatic is often but a step.” Single-minded conservatives please copy.

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TO WRITE THIS I had to turn off a television show featuring a rock star, eyes closed in rapture or agony or something, moaning an expression of his solidarity with the people starving to death in Africa. I should-and shall-leave the task of commenting on TV performances to Marvin Kitman. I will even resist the temptation of recalling the Stan Freberg skit of a few years ago in which he asks everyone to stop at a certain hour of a certain day and tap dance for peace.

There is no question that our fellow citizens’ capacity for pity and terror has been stirred by the pictures they have seen of the starvation in sub-Saharan Africa. There is no question that they want to help in some way. It would be pretty to think of them beginning by wondering how the tragedy came about. For anyone ready to take that necessary initial step there is a new book available called Debt Trap: Rethinking the Logic of Development. Yes, I am afraid that to understand starvation in Africa you must start with money and banking, because they are the roots of the problem.

The author of Debt Trap is Richard Lombardi, a former vice president of the First National Bank of Chicago. His office was in Paris, a nice place to have an office, but he was in charge of lending in both French-speaking and English speaking Africa, and he traveled widely and steadily in those countries. What he saw troubled him deeply, for he is an intelligent and compassionate man. To think about the situation in greater depth he took a leave of absence and became a research associate and Thursday Fellow in Georgetown University’s School of Foreign Service. The result is his important and enlightening work.

Lombardi lays out the connection of starvation with banking roughly as follows: People starve because they cannot get food. They cannot get food because they either do not grow it or have no means of securing it from those who do grow it. In Africa they do not grow so much food as they used to, since many farmers have moved to the city and many more have switched to crops for export, like sugar and coffee and cola nuts. Their governments have induced them to switch to export crops to earn foreign exchange. The governments need foreign exchange to try (unsuccessfully) to meet the interest payments on their foreign loans.

Why do they have foreign loans? It comes down to Gertrude Stein‘s answer when she was asked why she had written Tender Buttons: “Why not?” As Lombardi tells it, the world’s big bankers bought the oil sheiks’ OPEC winnings on the Eurodollar market and then jet-setted around the Third World peddling the money. The bankers called this recycling; actually, it was salesmanship.

The bankers happened to launch their maneuver at about the time that the Third World nations, almost without exception, were in trouble with the World Bank and the International Monetary Fund (IMF). The bankers could offer assistance because they had money and also because they had a new vision-not of banking, but of what they came to describe as “world financial enterprise.” Lombardi credits (if that is the right word) this vision to Walter Wriston, who transmogrified the First National City Bank of New York into Citicorp in 1967. At any rate, the “Citicorp Concept” was reverently discussed in the business press and widely emulated by David Rockefeller‘s Chase Manhattan and the rest. The hairy details I’ll leave you to read in Lombardi’s book, only noting Wriston’s fatuous dictum, “But a country does not go bankrupt.”

The stage was now set. The Third World needed (or wanted) money; the bankers had it (or knew where they could get it). And the bankers had convinced themselves that all Third World loans were risk free. What happened? In 1960, Lombardi tells us, Third World debt totaled $7.6 billion. Today, a quarter of a century later, it is nearly $1 ,000 billion that is, $1 trillion, or an increase of roughly 12,000 per cent. The sum is not owed to the banks alone. UN agencies are heavily committed, as are our Export-Import Bank and its counterparts in other First World nations.

All of this occurred because those who count in both the First World and the Third World have been acting out what Lombardi (using an unlovely but fashionable word) terms a “paradigm.” Two components of the paradigm we have discussed here before: Ricardo’s Law of Comparative Advantage (“How Our Sun May Rise Again,” NL, July 12-26, 1982), and the notion that a growing GNP cures all ills (“Sinking By the Numbers,” NL, May 2, 1983). A third principal component, perhaps not now so prominent as the others, is the theory of Walt Rostow (Lombardi erroneously calls him Walter) that developing societies invariably pass through five stages: “the traditional society, the preconditions for takeoff, the takeoff, the drive to maturity, and the age of high mass consumption.” A dream world.

In the grip of this paradigm, everyone began pushing the Third World to modernize and industrialize. The Export – Import Bank and its ilk underwrote sales of steel mills and sugar refineries and atomic energy plants. The national airlines of countries of fewer than a half million souls, most of them tribesmen with neither the need nor the possibility of flying anywhere, bought fleets of Boeing 747 jumbo jets. The World Bank lent money at low rates for roads and airports and dams and other infrastructure. The UN “Development Decades“ favored an urban focus, precipitating a population shift from farm to city. The demand for agricultural exports accelerated the shift, because export crops tend to be more efficiently handled by agribusiness than by customary methods.

Under such prodding the Third World’s GNP rose even faster than the Development Decades had hoped. But Third World debt rose faster yet. This outcome, which should be a puzzle to true believers in the GNP, threatened to swamp the UN agencies. The IMF (then as now) counseled austerity, meaning cut imports (or, more frankly, reduce your standard of living) and expand exports (done by lowering wages and, again, your standard of living).

At that point in time (as Watergate taught us to say) the Citicorp Concept flashed across the horizon. Gone was the old-fashioned bankerly attempt to evaluate the business prospects of each enterprise applying for a loan. In its place was the actuarial notion that lots of risks are safer than a few. Risk itself disappeared because countries did not go bankrupt. Recycling could go on merrily as long as Third World countries could be induced to borrow money at a point or two over what the bankers had to pay for it on the Eurodollar market.

It turned out not to be difficult to induce Third World countries to borrow, what with everyone advising them to do so and especially with fewer and fewer questions asked. Lombardi has some horror stories to relate. A billion dollar steel mill in Nigeria is too sophisticated to use the low-grade ore it was originally intended for. Zaire has the longest transmission line in the world, and no particular need for it at either end. A loan to Costa Rica was underwritten by a banking syndicate on the basis of a news article in Time.

At least some of the borrowers were foolish like fox terriers. They didn’t bother to buy so much as a new presidential palace with the money, instead sending it straight to numbered bank accounts in friendly Switzerland. Periodically, statesmen who had that kind of foresight were overthrown, and their successors opened up their own numbered accounts. No one knows how many billions thus disappeared. The critical fact, however, is that the bankers lending the money didn’t care; they lent the money to countries, not to individuals, and countries don’t go bankrupt, even when they are stolen blind.

Of course, countries whose debts have increased 12,000 per cent in 25 years do usually have trouble meeting even the interest payments. So the IMP urges austerity; food is in short supply; starvation looms-chronic starvation, not the sort that results from a natural disaster.

LOMBARDI paints the unhappy picture with great fervor. He emphasizes that the Third World’s troubles are not merely those of an exploding population. The population problem certainly plays a role, but in the improbable event of zero population growth troubles would remain. The key is breaking that paradigm.

Lombardi suggests ways this can be done. He also shows the trouble the paradigm has caused and will cause in the First World-that is, to you and me. For when bankers lend money to Brazil to buy a steel mill or to Tunisia to manufacture blue jeans or to Taiwan to keypunch data into American computers via satellite, Americans lose their jobs.

The apostles of the Law of Comparative Advantage (a.k.a. “free trade”) counter that building the Brazilian steel mill and the Tunisian garment factory and the Taiwanese data-processing equipment makes jobs for Americans, and to a degree they are right. An hour or two at, say, John F. Kennedy Airport in New York will convince you that Boeing has sold (with Export-Import Bank help) an awful lot of747s to foreign airlines you never dreamed existed. Still, unless we are prepared to give our airplanes and steel mills and wheat and corn away, someone has to pay for them-that is, the loans the bankers have made for us have to be paid off. If they can’t be paid off, our friendly bankers will surely find ways to transfer the bad debts to us taxpayers. And if they are paid off, Third World austerity programs will throw Americans out of work. “When bank credit to Mexico stopped in 1982,” Lombardi observes tellingly, “more jobs were lost in the following six months in the United States than in the three previous years of a depressed U.S. auto industry.”

Banking, in short, is not an innocent enterprise. It can cause starvation in the Sudan and unemployment in Cincinnati. Faulty practice flows from faulty theory. Faulty banking theory flows from faulty reading of history. Lombardi devotes several chapters to this question, and though I don’t always agree with him (in particular, I think he misunderstands evolution), I certainly applaud his effort. I therefore earnestly commend his book to your attention.

A useful supplement to the foregoing is The Dangers of “Free Trade,“ a new booklet by Professor John M. Culbertson of the University of Wisconsin-Madison. Culbertson details the mischief caused in both the Third and First Worlds by the Law of Comparative Advantage, then suggests new trade policies suited to the actual situation of the actual world we live in. He makes a strong argument for conducting international trade between nations (rather than between private citizens or firms), and he makes a persuasive case for bilateralism (showing that he’s not afraid of unconventional thoughts).

The New Leader

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IN MAKING the case “For a Labor Theory of Right” (NL, February 11-25), I remarked that “if you review all the problems of all the brands of economics, you will find that invariably the proposed solutions embrace or lead to some overt or covert control or depression of labor costs.” There is one fundamental reason for this, and two secondary reasons.

The fundamental reason is that anything wrong with an economic system shows up in the relation of price to values. If prices and values were identical, or roughly identical, the system would be perfect. Nobody would have a beef. Disordered prices are the sign of trouble, and life has troubles.

The first secondary reason is that the cost of labor is the largest component of the price of almost everything. For the economy as a whole, the cost comes to somewhere between 80-85 per cent of the gross domestic product. This does not mean that labor is getting a fair shake (quite the contrary), but it does mean that should you have a problem with prices, such as inflation or the need to close an international trade gap, labor cost is the obvious initial place to look for a solution.

The second secondary reason is that the most variable component of every price is profit. As S. Jay Levy and David A. Levy show in Profits and the Future of American Society, profit is essential for any enterprise, whether under a communist or a capitalist system. But profit varies, if only because sales are unpredictable. Wages and salaries are contracted for and can be fixed; rent and interest are contracted for and can be fixed, Profits are not contracted for and cannot be controlled. Consequently, by putting a collar on labor costs to hold down inflation, or for whatever reason, you are necessarily setting up a situation in which profits may be very high indeed, and stockholders will make a killing.

Can’t profits be controlled by taxation? Well, up to a point. I am reminded, however, of the 85 per cent excess profits tax of World War II. Each year at Thanksgiving time, book publishers began to see what their profits for the year would be (other industries pretend to be more farsighted; book publishing is inescapably myopic). If things looked good, they scurried around in search of ways to spend the profits before the tax collector got them. They couldn’t give unusual raises or bonuses because of wartime controls. They couldn’t invest in fancier offices because of a lack of materials and a lack of time. There was one thing they could do-advertise. As a result, the New York Times and the New York Herald Tribuneand all the other papers that then existed bulged with book advertising in December. What the newspapers did with their profits I have no idea.

You may be tempted to think that the extra advertising sold more books and therefore increased profits and taxes. If so, you will please stay after class and I’ll try to disillusion you about book advertising. For the moment, you may take my word for it that this was institutional advertising. The aim was to show the publishers’ flags to authors and their agents and perhaps sign up some good books for future years. Because of the excess profits tax, the institutional advertising cost only 15 cents on the dollar, and at the worst was a cheap way for publishers to massage their own vanity as well as that of their authors.

Similar tricks can be played with profits in any industry at any time. Plant and equipment can be expanded or renovated on an accelerated or more ambitious schedule. Offices can be moved or redecorated. Last year’s marvelous typewriters can be replaced by this year’s word-processing wonders. Expense accounts can be relaxed. Executive limousines can be stretched a few inches longer.

These effects are like those of the present depreciation law, whereby General Dynamics and others pay dividends in the billions and increase their net worth astronomically, yet pay negative income taxes. Profits can always be sheltered, and the benefits will always accrue to the owners of the companies.

Now let me take a different tack. As Perry Mason used to say, I’ll connect it up. I suggest to you that the kernel of truth in Marx’s class theory had nothing to do with dialectics or materialism, which are (forgive the color) red herrings.

Today’s classes have come into existence precisely because they have no material base. In fact, they have no base at all; they are committed to nothing. The structure of the modern corporation and modern financial markets has liquefied – almost vaporized – loyalty. Ownership flows mindlessly hither and thither in search of immediate profits. Even the owners of old and distinguished publishing houses like Scribner’s can see no virtue in maintaining their firm’s existence. The owners of individualistic magazines like the New Yorker can see no virtue in maintaining their publication’s independence. Stockholders in corporations deny that there is any intrinsic virtue in owning the enterprise. Modern finance has created a class that is a class because it is without virtue.

A class does not exist (as Marx noted) except in opposition to another class and the owning class has its foil in the working class. Since the former proclaims its lack of virtue, it is tempting to infer that the latter is virtuous; but it, too, because of the structure of our corporations, is unable to risk commitment.

Although Marx was right enough in seeking a resolution of class conflict, the Soviets have shown even old-line enthusiasts that state ownership merely breeds what Milovan Djilas called the New Class. In socialist but non-Marxist Britain, five years before the recent bruising strikes, feisty Lord Shinwell said: “I nationalized the coal mines, but do you think I’m proud of that? No, not at all. The wages are better and the safety conditions are better, but you’ve still got the same old class divisions. We got rid of the coal owners and replaced them with bureaucrats. Despite all the fine and lovely idealism, it went wrong.”

On the other side, conservatives are right enough in trying to preserve (or create) opportunities for personal endeavor and innovation. Unfortunately, as the modern corporation has developed, the incentives reward those who merely own money. They do little or nothing to inspire those who do the actual work of the economy.

HOW CAN the valid aims of the communists and the conservatives be reconciled and realized? The answer brings me to another argument for some form of employee ownership. Last time out I urged the justice of what I call the Labor Theory of Right. Here I want to urge the social efficiency of that theory. It is stating the obvious to say that if you want to control corporations in any way for any reason (I can think of many reasons), you will remove one major source of trouble if you are able to heal the split between capital and labor. That healing can be approached through employee ownership, and, I think, only thus.

Profit sharing has been touted as a method of doing the same thing. It may be a step in the right direction. But profits can be sheltered; then there is nothing to share, and labor (including management) is justified in crying foul.

The profit-sharing scheme put forward by Martin L. Weitzman in his book The Share Economy(the “Best Idea Since Keynes” proclaimed the headline of a New York Times editorial) contemplates labor negotiations settling on relatively low hourly rates plus (for each company’s labor force as a whole) a percentage of profits or of revenues (the latter would eliminate the sheltering problem). In accordance with this scheme, the marginal cost of hiring a worker would always be below the average cost, so (Weitzman contends) it would be in the interest of every company to hire as many people as possible. The expanding companies would in this fashion achieve economies of scale, which would allow lower prices, which would increase sales, which would maintain the economy in a fully employed and inflation free boom.

You will be persuaded by this reasoning if you believe that economics is a branch of mathematics. Then you will believe that economies of scale are always achievable and, moreover, always proportionate to the size of the work force. You will believe that the demand for any product always rises in smooth proportion to a decreasing price. You will believe with Jean-Baptiste Say, of the early 19th century, and Congressman Jack Kemp (R.-N.Y.) of today, that you can always sell whatever you make. You will believe that John Maynard Keynes was wrong in noting that most people, for various reasons, will not spend or invest all their money, and that their clear preference for liquidity – even if there were no other reason would render Say’s Law inoperable. (See “The Savings Bust,” NL, October 17, 1983.)

Beyond the foregoing (and additional considerations that can be found in the current issue of the Journal of Post Keynesian Economics), it should be apparent that, with the best will in the world, Weitzman’s scheme is yet another that solves the ills of the world at the expense of the working man and woman. Indeed, he considers labor a commodity, albeit one he has great respect for. Capital gains still go to those who do no work. The professor unwittingly gives the game away when he remarks that his plan is a sort of share-cropping. Against his handful of cases of allegedly beneficial share-cropping, any student of agriculture could cite volumes of disasters.

For my part, I am also made uneasy by Weitzman’s assurance that his scheme would, after a little tinkering, automatically eliminate our problems. I don’t know whether Milton Friedman is right in sayingthere’s no such thing as a free lunch, but I am quite sure that there’s no such thing as perpetual motion.

The New Leader

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I ENDED my previous column (“The Faith of Fiduciaries,” NL, December 24, 1984) with the scarcely original observation that the stockholders of public corporations, who are the legal owners, are neither willing nor able to accept responsibility for what the corporation does, while the workers (including the managers), who actually do whatever the corporation does, have no systematic reason for doing it well. No one is, or can be, loyal to anyone else. In the words of the Arab in Saroyan’ s The Time of Your Life, “No foundation. All the way down the line.”

This unhappy situation is implicit in the classical economics of the invisible hand, which is amoral at the start of its analysis and hence amoral in its conclusions. As the computer people say, “garbage in, garbage out.” More particularly, disorder is implicit in the structure of the limited liability corporation and in the impersonal liquidity of efficient securities markets. The recurrent waves of conglomerations, takeovers and greenmails have at last forced some commentators to recognize that there is a problem, though so far the proposed solutions – such as those of Peter F. Drucker in the Wall Street Journal have involved attempts to turn back the clock. Before we try to move the clock ahead, let’s take a brief backward glance of our own.

One of the hoariest problems in economics has been that posed by the Labor Theory of Value. Almost every great economist has held this theory in some form or other. The theme was announced by Adam Smith: “Labor alone, therefore, never varying in its own value, is alone the ultimate and real standard by which the value of all commodities can at all times and places be estimated and compared. It is their real price; money is their nominal price only.”

Smith’s successors stated the Labor Theory of Value in terms varying somewhat from his. David Ricardo contended “that it is the comparative quantity of commodities which labor will produce that determines their present or past relative value, and not the comparative quantities which are given to the laborer in exchange for his labor. … “Karl Marx put it this way: “How then is the magnitude of [use value] to be measured? Plainly by the quantity of the value- creating substance, the labor, contained in the article.” John Maynard Keynes held that “the unit of labor” was “the sole physical unit which we require in our economic system.”

Labor is a curious yardstick here in that, unlike money, it can scarcely be a store of value. Nor is it easy to say exactly what labor is. The Army sometimes taught rambunctious soldiers to mind their manners by having them dig a hole six feet wide, six feet long and six feet deep, and then fill it up again. There was plenty of labor involved in the exercise, yet not much economic consequence. Maybe, then, it wasn’t really labor, but only labor in a manner of speaking, that is to say, nominally. Additional difficulties arise in trying to find a fair equation of skilled labor and unskilled labor, efficient labor and inefficient labor, mental labor and menial labor, labor paid and unpaid, earnest labor and timeserving.

A perhaps more intractable aspect of the question is the fact that, assuming one could decide on a definition, it is obvious that the amount of labor in a product has only the most tenuous connection with its economic value, or price. The matter remains unresolved even when one recognizes (as one should) that capital is produced by past labor, and that land produces nothing except by the application of labor. It might be argued that what is valuable in a product is the result of labor, past or present. What is contemptible or dangerous or illegal in a product, however, is also the result of labor, past or present. Moreover, an unwanted product sells for little or nothing, regardless of the amount or quality of labor that went into it. In short, it is impossible to establish a connection between the Labor Theory of Value and price.

Nevertheless, the impulse behind the Labor Theory of Value is sound. Although not a source of value, labor is primary: it is the source of right. I would, in fact, supplant the Labor Theory of Value with a Labor Theory of Right. The right in question is ownership of the enterprise, not (as is sometimes proposed) ownership of the products of the enterprise. The distinction is important: An enterprise is dynamic, ongoing; its products are static, finished.

Ownership of an ongoing enterprise is different from ownership of a house or a drill press or any individual thing. An enterprise uses things – fixed capital such as factories and working capital such as inventories – but is not itself a thing. Ownership of an enterprise is a bundle of rights, including the right to control policy, to receive profits (or suffer losses), and to receive capital gains or the net proceeds in case of sale or liquidation.

The right to receive profits requires a little elucidation. Profits – like the enterprise itself – are not fixed. The profit (or loss) for a period is what is left over after sales have been made and expenses have been met. The conventional factors of production are land, labor and capital; and their conventional costs are, respectively, rent, wages and interest. All of these factors (and any others you care to name) can be, and generally are, contracted for in advance; their costs can usually be budgeted. Sales, on the other hand, can only be estimated. Under the circumstances, no matter how careful and sophisticated your cost estimating, there is always something left over – the profit or loss – because the future is constitutionally unknown. If the future were known, there would be no future, and so no present. Our autonomy was secured when Pandora’s Box snapped shut.

Insisting that something is always left over, we do not have to – indeed, we cannot – know where that something comes from. In some instances it may be the result of chance or a risk well run; in others, the chance falls the opposite way. Sometimes it is the consequence of war or pestilence (favorable conditions for certain enterprises). Sometimes innovation is richly rewarded; occasionally it is cruelly rejected. Sometimes vigor achieves wonders; other times what was hoped to be vigorous action proves to have been the rushing in of fools. Whatever we may decide, after the fact, to have been the source of a particular profit, an enterprise has no way of systematizing all sources of future profits and losses. For this reason, business firms, like armies, establish reserves that can be committed against disaster or for the exploitation of breakthroughs. Uncommitted reserves are undistributed profits.

IN CLASSICAL economic theory, profits go to the entrepreneur, the one who creates the enterprise and makes it function. Frank H. Knight argued in Risks, Uncertainty, and Profitthat in the modern corporation the entrepreneur is hired by the stockholders and therefore the profits go to them. But this imagined hiring is at best a legal fiction; it is not a personal action. The modern corporation, as I said in my previous column, is itself the entrepreneur. It is thus appropriate to inquire who the persons of the corporation are. Who are the people doing what the corporation does? Essentially, to return to my observation at the outset, they are the workers – skilled, unskilled, clerical, and managerial. Secondarily, they are those who provide the producers’ goods – the capital – of the corporation. Producers’ goods are of course themselves rooted in labor. Marx, a good man with a metaphor, called them “frozen labor.” Capital, no matter how defined otherwise, is saved labor.

Current labor and saved labor are involved in the act of production, so both are entitled to participate in the proceeds. The entitlement of current labor is immediate: The workers are present, and the sweat glistens on their brows. That of the owners of capital, by contrast, depends on their capital having once been a direct entitlement of labor. Hence it cannot rise higher than labor’s, which is its source.

The foregoing heads us in the direction of some sort of employee ownership. There are several sorts, and I could tell you a tale about them based on personal experience. For the moment, though, let me emphasize just two points.

First, if you review all the problems of the different brands of economics, you will find that invariably the proposed solutions embrace or lead to some overt or covert control or depression of labor costs. I mean all problems, from the allegedly benign effects of competition to the perceived malignity of inflation. Conservative economics would cure a depression by reducing wages; liberal economics would allow wages to drive the economy into an inflationary spiral that could be broken out of only by imposing wage and price controls.

The trouble with reducing wages or controlling them is that; since the future is constitutionally unknowable, there is no clean way of also controlling profits. It consequently turns out that the owners of the means of production (including the bureaucrats of a Communist state) generally lead invidiously comfortable lives when wages are controlled. This is not a just arrangement. The sole possibility of avoiding the injustice that I can see lies in the direction of the Labor Theory of Right.

The second point I would stress is that employee ownership is no more an automatic panacea than is the invisible hand. Supporters of the idea, from Boston department store owner Edward A. Filene to the present, have argued that ownership would stimulate employees to such a pitch of efficiency that their enterprises would sweep conventional competitors from the field, increase national productivity, and even reduce international tensions. It ain’t necessarily so.

And if it were, it would be economically irrelevant. As I never tire of saying, economics is not a matter of efficient production (that is engineering or agriculture). Economics concerns justice in monetary relationships among people. The power of the Labor Theory of Right is that it is just.

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A TOAST to mark the appearance of his Economics: What: Went Wrong and Why and Some Things to Do About It began our very pleasant lunch the other day with George P. Brockway. Published by Harper & Row under the Cornelia and Michael Bessie imprint, the book grew out of, and to a large extent expands upon “The Dismal Science,” the popular alternate-

issue column Brockway started writing for us in January 1982. Pleased as we indeed are about that genesis, it also poses a problem. And it is a measure of this man-who in his book insists “economics is … a branch of ethics” – that we could engage him in a detached discussion of our views on the impropriety of reviewing works essentially derived from the pages of the magazine.

We would be remiss, however, if we therefore did not commend to your attention what Robert Heilbroner, in an advance comment on Economics, has described as “marvelously well written, a joy to read,” as well as “full of original and perceptive observations.” Brockway deftly draws on his better than 40 years as salesman, editor, president, and chairman of the board at W. W. Norton and Company before his retirement in December 1983 to deflate many of the assumptions commonly held by professional economists. Most significant, though, is the people-oriented philosophy that informs his thinking, which may be gleaned from the following in his opening chapter:

” .. .In the early 1980s, when upwards of 14 million men and women in the United States were unemployed, and there was much debate about whether we were in a recession or a depression, and how to end whatever it was, public attention was lavished on statistics supposed to indicate when recovery was finally under way. Among the ‘indicators,’ the rate of unemployment was understandably included. But this was, curiously, a’ lagging’ indicator. That is to say, standard economics held that something entitled to be called a recovery could be achieved leaving 6 or 8 or 10 per cent of our fellow citizens unemployed.

“An economics that is thus willing to disregard several million people will clearly differ in substantial ways from an economics that holds that full and just employment of men and women is the economic problem, and that a business recovery may be a means to that end, but certainly is not an end in itself.[1]”

Guided by the same spirit, Brockway proceeds to offer several other ends, and the means for attaining them. Perhaps the most original dominates a chapter called “Property,”

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IN A RECENT issue of the Wall Street Journal, Peter F. Drucker, the most prolific authority on the modern corporation, made an impassioned case against unfriendly takeovers, suggested some ways of inhibiting them, and concluded that “none of the policies we are likely to adopt will solve the basic problem, the one created by the shift in voting power from ‘owners’ to ‘fiduciaries.‘” Drucker has worried about this problem for some time. In so doing, he pursues, perhaps unwittingly, an attack on the way much, perhaps most, business has been done in this country since the invention of the limited liability corporation.

The fiduciaries troubling Drucker are the trustees of pension funds and (though he does not mention them) of charitable endowments, churches, foundations, universities, and private trust funds generally. He estimates that pension funds alone control between one third and one half of the stock of our great corporations. And these trustees have, as he says, “a legal duty to accept whatever gives their beneficiaries the highest immediate return.”

The courts, it must be sadly recognized, will always look with favor on accepting the highest immediate return, because this is in accordance with the antediluvian economic notions they are possessed by. At least since Adam Smith, the actors in the economic drama have been supposed to seek their own gain and to be led as by an invisible hand to achieve the social end of a wealthy nation. In fact, the managers of mutual funds, whose obvious interest is to maximize their gains, are acknowledged by Drucker to vote for takeovers exactly as do the trustees of pension funds. On the takeover question, legal theory and business practice are congruent.

Nevertheless, Drucker sees in “the takeover wave that is engulfing American industry” a threat not only to the companies being raided but also to the companies used as vehicles of the raids. Nor is this all. The ever-present danger of a raid forces managements to concentrate their attention on the next quarter’s bottom line, even though long-range development is thus sacrificed to short term profits. This tunnel vision, Drucker holds, is a leading cause of the decline of America’s competitive strength. In addition, it results in the demoralization of companies’ employees, “from senior middle managers down to the rank and file in the office or [on the] factory floor.” Conservatively managed companies, which have prudently written down their assets to the lowest reasonable figure, are especially attractive takeover targets.

If things are as bad as Drucker says (and they are), something should be done about it. He suggests that the Comptroller of the Currency might forbid banks to lend money for unfriendly takeovers. For my part, in the general interest of inhibiting speculation I would forbid lending money to facilitate the purchase of any securities, I would have the Federal Reserve Board close down margin accounts, and I would try to persuade the Congress to end the special tax treatment of capital gains.

But these measures, desirable though they are, do not meet Drucker’s fundamental concern: the erosion of the idea of property. He would deal with that by reviving the ancient Roman understanding of property. The Romans, he says, held that ownership entailed a responsibility to the thing owned. A farmer must not mistreat his land. A workman must not mistreat his tools. Even a slave master must not mistreat his slaves.

In their turn, it may be added, the Church Fathers were throughout careful to balance rights with duties, and that evenhandedness is intellectually very appealing. Similarly, the standard picture of the entrepreneur of the early Industrial Revolution is emotionally very appealing. He was celebrated by Joseph A. Schumpeter as the man who gets things done. Even John Maynard Keynes noted that” if human nature felt no temptation to take a chance, no satisfaction (profit apart) in constructing a railway, a mine or a farm, there might not be much investment merely as a result of cold calculation.”

The classical entrepreneur defined himself through his enterprise. He was a textile manufacturer, a dry goods merchant, a railroad man. But to be a conglomerate person or a holder of a diversified portfolio is to be nobody in particular, with no commitment to anything except the bottom line – the bottom line being, indeed, the real reason for the conglomerate or the portfolio.

Today the typical corporation is itself the entrepreneur. Regardless of the occasional brilliance and frequent flamboyance of its managers, it is a public corporation. The profits (or losses) go to the stockholders, who own it. They, moreover, and they alone, have the right to sell the corporation or any part of it and to take for themselves the entire net proceeds of the sale. Yet as everyone knows, in reality the stockholders have nothing to do with the corporation beyond endorsing dividend checks and occasionally signing proxies, and this indifference is particularly true of the individual stockholders, whom Drucker in the end mistakenly celebrates. In contrast, fiduciaries and mutual-fund managers are likely at the minimum to have studied the quarterly statements and annual reports.

Not only do the stockholders have practically nothing to do with the corporation, most of them never wanted to have anything to do with it. They merely had some money and were eager to place it where it would be reasonably liquid and have a chance of returning something more than bank interest. The 19th-century invention of the limited liability company was a blessing for such people, and the blessing was magnified by the development of efficient securities markets. Since, with negligible exceptions, shares are” fully paid and nonassessable,” those who hold them do not have to worry about the company’s debts or legal involvements, or fear the loss of more than they paid for the stock. Because they can sell out at any time, they need not fuss either about providing alternatives to company policies they find dangerous or unsatisfactory.

The owners of a limited liability corporation accept no responsibility. They would not have become involved if responsibility had been expected of them. How could they have known that the gasoline tank of the Pinto was unsafely designed? How could they have known that DES might cause cancer? How could they have known that exposure to asbestos could lead to leukemia 20 years later? Assuming there was some way knowledge of this kind could be made available to stockholders, it still would be impossible for individuals holding a few shares or even thousands of shares to participate effectively in the daily operations of Ford or Lilly or Johns Manville. On the other side, the managements of those companies would claim they could not operate with participatory ownership. Apart from the confusion that would result, they could not then protect trade secrets (whatever these may be).

HAVING no responsibility other than to the thickness of their pocketbooks, individual stockholders will do what is necessary to get the highest immediate return precisely as fiduciaries and mutual- fund managers do. Thus they will put pressure on brokers to find them companies (new or old) that will bring quick returns; brokers will put pressure on investment bankers to float the issues of such companies; investment bankers will put pressure on commercial bankers to give priority to the needs of such companies; and all pressure will be brought to bear on the management of every public company to do whatever it can to increase the bottom line.

There you have the triumph of finance over enterprise. In these circumstances, loyalty is, as Drucker observes, comprehensively destroyed. No one is or can afford to be loyal to the enterprise – not the owners, not the fiduciaries, not the financiers, not the management, not the work force. Nor are owners, fiduciaries, financiers, managers, or workers encouraged to be loyal to each other. This atomization of concern is doubtless a major cause of the widely deplored decline in standards of workmanship and service. It is certainly a major cause of increased speculation on Wall Street.

The public consequences of atomization are matched by private consequences, whose severity cannot be overemphasized. Loyalty is one of the fundamental virtues; Josiah Royce held it to be the fundamental virtue. Deprive men and women of the opportunity for loyalty, and you shrivel their souls. Encourage them to be disloyal, and you corrupt them. Cynicism cannot cure itself; it must be surprised – happily by joy, unhappily by catastrophe. The damned are those who are not surprised.

We find ourselves in danger of this damnation because of the success of the limited liability corporation and the efficiency of today’s security markets. Drucker would cure our cynicism by barring pension funds – another successful idea with unexpected consequences – from owning shares in corporations. But what is true in law of the trustees of pension funds is equally true of the trustees of eleemosynary institutions. And it is true in practice of practically each individual stockholder as well as of the managers of mutual funds. All of these people are – in business practice and legal theory – interested only in their own gain. None – in fact or in theory – has a responsibility to the corporation that happens to be, for the moment, their property.

Who, then, is left? Who in the modern public corporation is willing and able to accept duties to balance the rights of ownership? No one. The stockholders assert the rights of ownership but accept no duties. The workers, including the managers, have no ownership rights and reasonably shirk the duties that might balance those rights. Financiers, fiduciaries, brokers, bankers, and speculators are totally irresponsible. What is to be done? I will address that question in my next column.

The New Leader

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I SUPPOSE I should say something about Secretary of the Treasury Donald T. Regan‘s recent Federal tax simplification proposals. As it happened, I was vacationing in Florida when they were announced and for a couple of weeks thereafter, so my initial information was limited to the local newspaper’s reports and the charismatic pronouncements of NBC’s Tom Brokaw.

The story filtering through to me and my neighbors was sufficiently vague on the interest-expense question to allow me to hope that one of my private ideas had a chance of becoming public law. It seemed that interest expense (with the exception of that on a primary-residence mortgage) would no longer be deductible. This certainly exercised the Sunbelt real estate operatives. It seemed, too, that the change would cover the interest expenses of businesses as well as of individuals. The latter, I have since discovered, is not the case. But I was briefly delighted for the following reasons, which I now offer in the event anyone asks you how the law should be revised.

Contrary to general opinion, the interest-expense deduction works mostly for the benefit of people with money to lend. It does nothing much for those with the need to borrow – especially not for those in the lower tax brackets. The first fact to bear in mind is that the interest rate is in one respect like other prices: It can’t go higher than the market will bear. You can’t get blood from a stone. If lenders attempt to set the rates too high, they will be left with idle money on their hands. If they do nothing with that money, they will be like the unfaithful servant inthe Parable of the Talents. To get their cash out and working, they must lower the rates to levels that businesses and individuals are able and willing to pay.

Although borrowers are subject to euphoria, businessmen are restrained by the necessity to make a profit, or at the minimum to make ends meet. For some months now, despite the well -advertised recovery, profit rates have been falling. And so have interest rates. The connection between the two is indirect, not direct. Interest rates have been coming down partly because the Federal Reserve Board has slightly relaxed its control of the money supply, but mainly because there has been a declining demand for loans. Many businesses have not been pursuing loans for the simple reason that business isn’t good enough for them to afford the rates asked.

The second fact is that the corporate tax deduction for interest expense cuts the cost of business borrowing roughly in half, at least for the bigger borrowers. In other words, at the present time some businesses are able and willing to borrow money effectively costing them, say, 6 per cent, not the 10.75 per cent (or a point or two more) they pay their friendly bankers before taxes. It is consequently reasonable to foresee that, if the interest-expense deduction were abolished, the demand for loans at 10.75 per cent would truly plummet, callable bonds would be called, refinanceable loans would be refinanced, lenders would be drowning in money to lend, and the interest rate would have to drop until solid ground was reached again. For various reasons (including, we may be sure, inappropriate reactions of the Federal Reserve Board), the rate would probably not fall quite to the present effective rate of 6 per cent. Nevertheless, observe the outcome: Abolition of the interest-expense deduction would leave borrowers about where they were, while the take of lenders would be cut almost in half. To repeat for emphasis, the interest-expense deduction mainly subsidizes those with money to lend, not those eager to put it to work[1].

Obviously, introduction of the change in a hurry would hurt many individuals, businesses and banks. The suffering of most individuals and businesses would be assuaged by the promised reductions in the tax rates, but the crisis in banking might be acute. Don’t get me wrong. If it were not for possible damage to the economy (and this could be mitigated by phasing in the change-over two or three years), I could regard a pit full of squirming bankers with a fair show of equanimity. My point has nothing to do with my feelings for bankers, some of whom are my best friends (though not always when I need them). My point is that the interest-expense deduction makes usurious rates seem tolerable. It is a prop holding up those rates for the enrichment of money lenders. I therefore thought Regan was absolutely right in trying (as I mistakenly understood it) to knock out this deduction.

Of course, I feared there wasn’t a prayer that he would prevail, despite the fact that everyone -everyone in the whole wide world (except for big lenders) – is longing for interest rates to come down. Last year, even with a more docile Congress and strong support from a not-yet-lame-duck President, the Secretary couldn’t get the banks to withhold taxes on interest – a measure that would have hurt only cheaters and the people who encourage cheating.

ALSO DOOMED (I thought, and still think) is Regan’s proposal to get a rein on the charity deduction. The churches and the colleges, the foundations and the funds, the museums and the libraries, the clinics and the think tanks – all the eleemosynary institutions in the land – are up in arms about this one. It is very sad and disillusioning. Many undoubtedly worthy, dedicated and, yes, necessary citizens have been tricked by the issue into making fools or hypocrites of themselves. Two pitiable examples turned up in the Florida paper I read.

An official of the local United Way observed that the median income thereabouts is $17,000, and he worried that the vast majority of its contributors would not be able to continue their generosity if the law were changed. The United Way does its supporters an injustice. For it is surely true that practically all taxpayers with a gross income of $17,000 take the standard deduction and make most of their contributions because they want to, not because it is a way of diddling the tax collector.

A local parson had a clearer under-standing of finance – and of his parishioners. He argued that Secretary Regan’s proposal to cut the top tax rate from 50 to 35 per cent would greatly reduce the value of the charity deduction to those in the top bracket. He is certainly right. Rich people are in (if the parson will forgive me) a hell of a fix. We’ve been told since New Deal days that high taxes sap their incentive to work and save. Now we discover that low taxes sap their incentive to be charitable. Of such is the Kingdom of Heaven.

The local Salvation Army made a more responsible observation. It noted that the talked – about budget cuts (a.k.a. “freeze”) in welfare programs would increase the calls on private charity, while the tax changes would reduce contributions. Indeed, one wonders (to introduce a little of the spice of argumentum ad hominem into the discussion) what the President himself might be expected to do in these circumstances. You will remember that the Treasury proposes to count only contributions in excess of 2 per cent of adjusted gross income. You will also remember that the President’s tax returns have rarely (if ever) shown contributions up to or much beyond that level. Add to this the fact that he promises to cut his own pay, and I am led to suspect that his favorite charities won’t be able to count on him (and on many like him) as they have in the past.

There is no doubt that the charity deduction is grossly abused (mostly in ways I haven’t discussed). There is little doubt that Secretary Regan’s modest proposals for its reform will fail. Then we have the matter of no longer allowing the Federal deduction for state and local taxes. Here I think the Secretary has his best chance of succeeding.

Perhaps the most important single change advanced by the Treasury would eliminate most of the corporation investment credits and rapid-depreciation dodges. These allow companies like General Electric to have profits in the billions and pay no income tax at all, but instead receive rebates of a hundred million or more. The change was not deemed worth mentioning by my Florida paper. Maybe the editor foresaw that lobbyists would not have much trouble explaining to the President that his major campaign contributors would hardly be amused.

THE FOREGOING are only the principal ways the Secretary of the Treasury has gotten people mad at him. An indicator of the wrath he has incurred is that as staunch an Administration ideologue as William F. Buckley Jr. finds the program a disaster. This being the case, why did Regan make his irritating tax proposals?

In answer, I’ll venture the guess that he is playing the game perfectly straight, yet that the result will neutralize the Democrats. For the Regan plan is very close to (actually more liberal than) the one put together by Senator Bill Bradley of New Jersey and Representative Richard Gephardt of Missouri (see “A Cautionary Tale of Tax Reform,” NL, January 23), which has wide verbal support, especially among neoliberals. It would thus seem that with a substantial majority of Republicans and a scattering of Democrats, a melding of the plans – including the somewhat similar scheme of Republican Representative Jack Kemp of New York – might have a good chance of sailing through.

If it does, the new law will certainly have the nice low rates that have been proposed. You should not be surprised, though, if the lobbyists manage to keep most of the loopholes open. For my part, I’d not be surprised if Republicans and Democrats started bidding against each other, as they did in 1981, to see who could give the lobbyists more of what they want. The not impossible result could be both lower taxes and wider loopholes.

What then?

The first consequence would be, as in 1981, an upward surge of the deficit. The second consequence would be, as in 1982, a move (over the obviously sincere opposition of President Reagan) to increase Social Security taxes (although they have no bearing on the budget deficit) and reduce Social Security and Medicare benefits. The third consequence would be, as in 1983, the realization that controlling the deficit requires some brave new taxes. It would be explained that the campaign pledges of no tax increase have after all been honored, since the income tax rates actually were lowered. But something had to be done.

What would it be?

Few fortunes have been made by people acting on my prophecies. Still, if I were a betting man, I’d wager that we would start hearing a lot more about the value added tax – how widely it is used in Europe, how invisible it is in comparison with the sales tax, how comparatively easy it is to collect, how it taxes consumption rather than production (a fallacy I have discussed more than once).

I know the smart money says that former Democratic Representative AI Ullman of Oregon was defeated in 1980 because he supported a value added tax; that references to it in the last campaign drew a strongly negative response; and now even the Treasury has come out against it. Nonetheless, with the income tax rates down and the loopholes wide open the pressure to act would be very great. On other occasions Secretary Regan has argued for a tax on consumption, and so have people as far to his left as Senator Gary Hart of Colorado. The American Enterprise Institute and the Brookings Institution similarly want to tax consumption.

My prophecy stands. What we get won’t be called a value added tax, but what’s in a name?